To Bulk Up MSN, Microsoft Will Cough Up $1.1 Billion

To cap its conference on Internet advertising last week, Microsoft rented out the Seattle Mariners' Safeco Field for a grand finale to an event that had already included speeches by Bill Gates, Steve Ballmer, and hip-hop impresario Jay-Z. The setting was outsize--but a drop in the bucket compared with the extra $2 billion Microsoft will spend to pump up its Internet strategy.

Microsoft last week acquired three companies, rolled out a new Internet advertising engine, struck deals to produce original video programs on MSN, and said it would double R&D spending for the unit. "Now is not the time to scale back the scope of our ambition or the scale of our investment," CEO Ballmer wrote in a memo to employees. Microsoft held a 13.2% share of Web searches in March, according to market researcher comScore Networks, while Google held 42.7% and Yahoo 28%.

But Microsoft's stock dropped after the company disclosed it would spend $2 billion more than expected in fiscal 2007. The money will go toward building up Internet infrastructure, adding manufacturing capacity for Xbox 360s, marketing new versions of Windows and Office, and hiring. Microsoft lowered its earnings forecast for next year. Credit Suisse analyst Jason Maynard, in a research note, said the lowered forecast reflects the threat software as a service and online business models pose to Microsoft's PC-centric franchise.

The company is moving fast to respond. Ballmer disclosed plans to double MSN's R&D spending to $1.1 billion in fiscal '07. Microsoft's new adCenter software can serve ads that reflect a PC users' location, age, gender, and demographic profile, in addition to search terms. DoubleClick and Avenue A/Razorfish are among the agencies buying ads that the system serves. This summer, Microsoft plans to start serving ads based on the content of pages and eventually extend adCenter to its Windows Live and Xbox Live services, says Karen Redetzki, a product manager at MSN.

Microsoft struck a deal to create original video programming for MSN--another vehicle for ad placement. Its acquisitions are Massive, a video game advertising company; DeepMetrix, which makes software for analyzing Web usage; and Vexcel, which develops radar systems and software for analyzing geographic data. The Vexcel technology will be used to enhance Microsoft's Virtual Earth site.